For South African importers and exporters, currency movements affect far more than the final payment on a shipment. They influence landed costs, freight charges, supplier payments, export pricing and margins between the date a contract is signed and the date payment is made.
Currency risk is nevertheless often treated as something for the finance team to worry about only when a large payment is approaching. A forward contract is taken out, a rate is locked in and everyone moves on until the next transaction.
The problem is that this is only one part of managing currency exposure. In my experience, a surprisingly large proportion of South African importers and exporters still do not actively manage their foreign exchange exposure as part of a broader financial strategy.
Given how volatile the rand can be, this should be on the radar of every leadership team with meaningful international revenues, costs, assets or ambitions.
The recent strength of the rand provides a useful reminder. During August, the currency traded around the R16/US$ level, supported by international factors including a weaker US dollar as well as improving sentiment towards South Africa and expectations regarding the country’s economic outlook.
I am not suggesting that businesses should attempt to predict where the rand will go next. In fact, my point is that businesses should be structured so that they are not overly dependent on getting that prediction right.
The well-known Big Mac Index provides an interesting thought experiment. It is certainly not a tool that should determine a hedging strategy but its purchasing power comparison suggests that the rand is significantly undervalued against the dollar. On a like-for-like Big Mac comparison, the implied exchange rate is around R9.50/US$.
Nobody is suggesting that the rand is suddenly going to strengthen to R9.50 to the dollar. However, it creates an interesting “what if” scenario for leadership teams to consider.
What would happen to the business if the rand strengthened even a third of the way towards that level? Would margins remain intact or would the business suddenly discover how dependent its profitability has become on a weak currency?
This is particularly relevant for South African exporters. A weaker rand can make locally produced goods more competitive internationally and translate foreign earnings into more rand. Over time, however, it can also hide inefficiencies in the underlying business. Costs can creep upwards while margins appear healthy because the exchange rate is doing some of the heavy lifting.
When the rand strengthens, those inefficiencies become more visible. That is why I believe managing currency exposure must go further than simply hedging contracts or buying forward cover.
An importer may quote a customer while goods are still being manufactured, only to pay the overseas supplier, shipping line and other dollar-denominated charges several weeks later. An exporter faces the reverse risk when foreign revenue is converted into rand. In both cases, currency movements can materially change the profitability of the transaction.
Where is your cash working hardest?
One area that deserves more attention is how businesses structure their cash. As South African banking products have evolved, businesses increasingly have the ability to hold funds in US dollars, euros and other major trading currencies.
There can be good reasons for doing this, particularly when a business has future liabilities such as supplier invoices, freight charges or other costs payable in that currency. The problem arises when a foreign-currency account effectively becomes a hedge against rand weakness without management necessarily recognising it as such.
A South African business may decide to keep a large amount of cash in dollars because it is concerned that the rand will weaken. If the rand strengthens instead, the business has taken the opposite side of that currency movement and may find that the value of those funds falls materially when translated back into rand.
There is also the question of what that cash is earning while it sits there. Depending on the institution, balance and product, a US dollar call or deposit account may offer a materially lower interest rate than an equivalent rand-denominated account. The business therefore needs to weigh the currency protection it believes it is receiving against the return it is giving up.
This is a broader treasury question than simply asking whether the rand will strengthen or weaken. Where is your cash working hardest, what future liabilities are you matching and how much currency exposure are you comfortable carrying?
International growth changes the conversation
The discussion becomes more complicated when a South African business expands internationally. Many entrepreneurs build intellectual property locally, gain traction in international markets and then consider whether that intellectual property should be housed elsewhere.
At this point, decisions that may initially appear relatively simple can have significant financial consequences. The externalisation or licensing of South African intellectual property must be considered carefully from a valuation, tax and regulatory perspective, particularly where transactions take place between connected parties.
The same applies to where international profits are held. Jurisdictions such as the US, UK and Ireland remain popular with South African businesses while Dubai has attracted considerable interest because of its accessibility and positioning as an international business hub.
For businesses looking to trade more extensively across Africa, Mauritius is another familiar option. Botswana may also be worth considering, depending on the nature and footprint of the business.
In my view, none of these jurisdictions should be selected simply because they appear to offer a favourable tax rate or because another South African business has chosen them. Transfer pricing, withholding taxes, double taxation agreements, exchange control requirements, the location of employees, where value is created and how profits ultimately return to shareholders must all be part of the discussion.
Getting these decisions wrong can become expensive very quickly. A structure that appears efficient on paper may look considerably less attractive once the full tax, currency and regulatory consequences are understood.
Currency risk starts before the transaction
Too often, currency movements are considered only at the point of transaction. An invoice arrives, somebody checks the exchange rate and the finance team decides whether to convert the funds or take forward cover.
Sound financial strategy is developed long before that point. Leadership teams should understand which currencies the business is naturally exposed to, how margins respond to different exchange rate scenarios, where cash is held and whether international structures still make financial sense.
The rand is too volatile for businesses with meaningful international exposure to leave these questions to chance. A relatively small currency movement on a large contract, cash balance or offshore revenue stream can quickly translate into hundreds of thousands, or even millions, of rand.
Hedging remains an important part of managing that risk but it is not the be-all and end-all. Currency exposure also affects cash management, profitability, tax, intellectual property, international expansion and the overall structure of a business.
I do not believe the most important question is where the rand will move next. For importers and exporters, the real question is whether their pricing, contracts, cash holdings and margins are prepared for whichever direction it takes.
